A Net-back Analysis of Irrigation Water Demand in East Anglia

In the United Kingdom, water allocation is governed by an administered licensing system, with charges unrelated to economic or environmental costs. Such a system is unlikely to result in an economically optimal allocation of water because it takes no account of the costs and benefits of each water use. However, the efficiency of the system can be improved by performing a “net-back” analysis. This paper performs a net-back analysis on irrigation water demand in the East Anglia region of the U.K. First, the simple net-back model is introduced, before existing data is used to estimate farmersʹ willingness to pay for irrigation water, both with and without the effects of agricultural and trade subsidies. This estimate is then compared with estimates of the long-run marginal cost of water. We find that farmersʹ willingness to pay (their “net-back”) is initially higher in general than the long-run marginal cost of irrigation water. However, once agricultural subsidies are removed, the net-back becomes significantly negative for all crops except potatoes. In other words, agricultural subsidies are the main factor in determining the profitability of agricultural production in East Anglia. If the markets for agricultural products and water services were perfect, only potatoes would continue to be grown and irrigated. With this in mind, we offer some conclusions concerning the current mechanism for water allocation in the U.K. In particular, the licensing decision could be used to attempt to replicate the allocation of water which would pertain if markets were perfect, as identified by our net-back analysis, thereby increasing efficiency.